A lot of my clients have been calling lately about their 2nd mortgages and home equity lines of credit. Lenders have been freezing credit lines and reducing high credit limits, decreasing the available credit to homeowners and making a lot of people quite upset in the process.
Just to clear up a common misconception, a home equity line of credit IS a second mortgage, a type of second mortgage. A handful of years ago, lenders realized that the term “2nd mortgage” was much less appealing than “line of credit” so the marketing term for a revolving credit line that is lien’d against a property in 2nd position (the house serves as collateral for the repayment of the debt), is just that, a mortgage in second position (2nd mortgage). This is important in understanding and explaining, why in fact, your second mortgage lender does not hate you.
First, let’s talk about lowering credit limits. Are lenders allowed to do this? And, if they are allowed to lower credit limits, why are they lowering credit line amounts?
First – is the lender allowed to lower the high credit limit on your second mortgage? Yes, probably. You will need to read through your closing paperwork to find your “Home Equity Line Agreement” or “Line of Credit Agreement” (or something similar) and look for a heading titled Suspension or Reduction of Credit Line. Under that section, you will likely see something similar to the following language:
“Suspension or Reduction of Credit Line. Bank can refuse to make additional extensions of credit or reduce your Line if you breach a material obligation of this Agreement in that: The value of your Dwelling securing your Line declines significantly below its present appraised value for purposes of the Credit line.”
The phrase “declines significantly below its present appraised value” is up for interpretation, but, in a nervous mortgage market and a declining value real estate market, any decline in value means big risk for the 2nd mortgage lender. Here is an example: Let’s assume you did an 80-15-5 to purchase your home for $300,000. Your loan amounts were for 80% = $240,000 and for 15% = $45,000 and put down 5%. Similarly, you could assume that you did a 95% LTV (loan to value ratio) 2nd mortgage at some point after closing for home improvements, emergency cash reserve, etc. If your 2nd mortgage was a line of credit, the outstanding balance is probably about the same, around $45,000 (most credit lines have monthly payments of interest only). If you home has decreased in value by 10% (the Atlanta market data from 2009 shows deceases in home values in the range of 8 to 20%), your home is now valued at only $270,000. After 3 years, you have paid down your first mortgage to $230,600 . . so the 1st mortgage and the 2nd mortgage total $230,600 + $45,000 = $275,600 — BUT, is only worth $270,000. If your loan goes in to default and the property to foreclosure, the 2nd mortgage company is SURE to lose money — and probably quite a lot.
So that leads us to the second question (although I think I may have already answered it): why are second mortgage lenders lowering and freezing credit lines? Why? Because they don’t want to lose money. And, by “lose money” I mean, “they don’t want to lose MORE money than what they are already losing on all of the foreclosed, short-sale and distressed sale properties.” They don’t want to lend more money than what can be expected to be recouped in the case of default. It’s business . . . not personal.
It’s not that they don’t like you, in fact, as you continue to make your monthly payments (assuming that you are), they like you more and more as each month passes.